At its most basic, a self-funding credit network is a system where lending capital is generated and sustained internally. Reducing the reliance of any credit network on external sources of funding makes it more resilient by insulating it from outside market forces. Traditional lending programs may run into serious problems if they were to ever lose access to a key supply of seed capital.
Self-funding networks rely on their own internal support structure, so they shouldn’t have these problems. When issues arise, they’re normally able to recover from them without having to rely on outside intervention. There’s also the possibility that they’ll enjoy greater levels of profitability as a result. Much of that has to do with the fact that digital lending platforms stand on solid fundamentals.
Building Your Basic Funding Mechanics
Though the process of starting a self-funding network can be rather complicated, the underlying concepts are actually quite simple. Three basic core components are at the heart of almost every self-funding credit network:
- Capital recycling programs encourage fund managers to put repayment money back into the network, which is then used to fund future loans.
- A good risk management strategy consisting of strong underwriting policies and a diversified borrower base can limit the number of bad loans that customers default on.
- Technology infrastructure, including all of the latest artificial intelligence (AI) and automation tools, helps manage the overall scale of the operation. Smart contract software ensures things work as efficiently as possible.
Credit networks shouldn’t have any difficulty funding themselves once all three of these factors are in place. Membership and participation fees provide the basic seed capital for a digital lending platform, which gets lent out to borrowers. Unlike a traditional lending institution, credit networks can dynamically set interest spreads that ensure sustainability over time without cutting into the pool of new customers. Most funds also put incentive structures in place that reward borrowers who repay their loans on time and simultaneously penalize accounts that default on them. That helps to build investor confidence while keeping good customers happy.
A strong digital lending platform will forge relationships with existing private capital markets to supplement their liquidity. Funds that build solid partnerships can continue to grow even if the financial industry faces outside challenges. Managers will usually lay down a series of special rules that spell out how they’ll handle any situation no matter how novel.
Establishing Good Trust and Governance Polices
Spelling out a set of clear rules about who participates in a credit network is the best way to ensure that everyone knows what’s expected of them. Oversight and compliance mechanisms built into these rules provide automatic feedback when something happens. When unusual situations arise, network managers will have the tools they need to take care of them without disrupting normal business operations.
By putting every governing policy in the open, self-funding credit networks have cultivated a very transparent reputation. Tech-savvy entrepreneurs have leveraged the power of blockchain-based software, which makes an indelible record of every single transaction that comes their way. Distributed ledgers provide a secure audit trail that allows users to know exactly when a specific amount of money changed hands. Organizations that store their transactions in a blockchain-based data structure will have unique records for every exchange, and each of these will feature its own hash code. While this technique leverages the same kind of technology that powers cryptocurrency transactions, credit networks usually deal with actual hard currency.
Advantages of the Self-Funding Model
Conventional centralized lending networks often have a single point of failure. Newer self-funding networks feature a distributed model that spreads the responsibility of running them out over every participating node. As a result, they’re far more efficient than those based around legacy models. A self-funding network won’t collapse merely because something happened to a couple of nodes. They’re capable of withstanding both technical difficulties as well as those posed by global financial shifts.
Greater efficiency can translate into lower costs for borrowers. Their decentralized nature also means that well-run self-funding networks can operate independently from traditional banks and external investors. They’re scalable enough that whole communities or fintech ecosystems should be able to deploy them without any problems. Individuals interested in ethical investment opportunities have found that credit networks are a great fit for cooperative lenders.
Challenges Associated With a Network
Legal issues are among the first that anyone building a self-funding network are likely to run into. Many entrepreneurs who plan on building their own credit network may not have much in the way of experience dealing with regulatory bodies. It’s best to work with a group that understands regulatory compliance so they won’t run afoul of any governmental policies.
Building user trust could also be difficult at first since potential clients may have never come into contact with such an innovative credit network before. Educating future customers about the way your network funds itself can go a long way toward ensuring that they feel comfortable enough to join. Creating an inclusive network that invites people from all walks of life is certainly a noble goal, but it can be difficult to do so while trying to minimize risk exposure. Keeping the network liquid may even prove to be a problem if economic conditions worsen over time.
Looking Toward the Future of Self-Funding Credit Networks
In spite of all these difficulties, the future of self-funding credit networks looks surprisingly bright. AI-powered predictive analytics can help fund managers make better decisions, thus reducing the amount of risk they have to deal with. Integration with decentralized finance (DeFi) ecosystems and the possibility of forging new relationships with more traditional banks make it possible for independent credit networks to enjoy sustainable growth. Entrepreneurs who want the freedom promised by the DeFi world but don’t want to sacrifice stability will especially appreciate these kinds of unique relationships.
Though predicting the direction of various financial markets is never easy, these tools are making it possible for entrepreneurs to build a strong digital lending platform that’s ready for an uncertain future.
